Saudi Arabia’s currency peg is no longer sustainable amid a slump in oil prices that threatens to further crimp government financing, according to Commerzbank AG.
The cost of buying 12-month dollar-riyal forwards has risen almost 1 percent since early December to about 3.83 per dollar, Commerzbank said in a report on Tuesday. Upward pressure on the forwards will probably increase over the “coming weeks and months,” it said. Saudi Arabia has pegged its currency to the dollar at 3.75 since 1986.
“Markets clearly no longer believe that the USD-SAR peg is durable,” said Peter Kinsella, an analyst at Commerzbank in London, who recommended investors take “long” dollar-riyal positions. “If they did, then forwards would not diverge from spot prices to any large extent.”
Saudi Arabia’s currency policy has come under increasing scrutiny as oil capped the biggest two-year loss on record in 2015 amid a global supply glut exacerbated by OPEC’s decision to effectively abandon production limits. The kingdom’s foreign reserves slumped by almost $97 billion last year to $636 billion, according to data from the Saudi Arabian Monetary Agency. Oil income accounted for more than 80 percent of the country’s revenue in 2014.
The government last month released a more tight-fisted budget for 2016, reflecting scaled-back revenue expectations and lower spending on subsidies because of sinking oil prices and its involvement in the war in neighboring Yemen. The budget envisions cutting expenditures to 840 billion riyals ($224 billion) this year after spending reached 975 billion riyals in 2015, 13 percent above target.
“The Saudis could put off the day of reckoning by engaging in severe budget cuts which reduce the deficit,” Kinsella said. “However, this policy is not without domestic political risks and does not seem to be favored by the authorities.”